California’s Municipal Bankruptcies Sign of Stigma Waning

People walk in the civic center of San Bernardino, California. Photographer: Jonathan Alcorn/Bloomberg

July 12 (Bloomberg) -- Bankruptcy decisions by San
Bernardino and two other California cities only weeks apart may
signal that municipal insolvency, while still a last resort, is
losing its stigma.

The City Council of San Bernardino, a community of 209,000
east of Los Angeles, joined Stockton and Mammoth Lakes in
agreeing July 10 to seek court protection from its creditors,
the first such filings since 2008.

“Do I expect more? Yeah, but I don’t expect a tidal
wave,” Dick Larkin, director of credit analysis for Herbert J.
Sims & Co. in Iselin, New Jersey, said yesterday by telephone.
“I am starting to wonder whether or not the stigma of
bankruptcy in California is going to be taken more lightly
now.”

Cities and towns across the U.S. have been strained by
soaring costs for labor including pensions and retiree health
benefits, while sales- and property-tax revenue plunged after
the longest recession since the 1930s. Stockton, a community of
292,000 east of San Francisco, on June 28 became the biggest
U.S. city to enter bankruptcy.

California is among at least 27 states that allow
municipalities to file for Chapter 9 bankruptcy protection,
according to Meagan Dorsch, a spokeswoman for the National
Conference of State Legislatures in Denver.

“It’s still no honor to be a Chapter 9 debtor, but if it’s
your only alternative, that’s what you do,” said Marc Levinson,
the bankruptcy attorney for Stockton and for Vallejo, a city of
120,000 in the San Francisco Bay area that filed for court
supervision in 2008. Chapter 9 of the U.S. bankruptcy code
covers municipalities.

Unaffordable Judgment

The third recent bankruptcy was filed by Mammoth Lakes, a
mountain resort of 8,200 that sought protection July 3, saying
it can’t afford the $43 million it owes on a legal judgment,
more than twice the size of its annual general-fund spending.

A bankruptcy filing can increase the cost of borrowing or
make it more difficult to access the capital markets in the
future, Lisa Washburn, a managing director at Municipal Market
Advisors in Concord, Massachusetts, said yesterday.

“It’s worrisome to see them close together but I don’t
expect that there will be a tsunami,” she said in a telephone
interview. “We may see an uptick, but I think they’ll remain
isolated instances.”

John Moorlach, an Orange County supervisor who became
treasurer after the county lost $1.7 billion on interest-rate
bets and entered court protection in 1994, said he expected more
cities to follow.

“The dominoes are starting to fall,” Moorlach said
yesterday in a telephone interview. “You’re going to get
something every week, every month.”

Mediation Option

Last year, the California Legislature enacted a union-backed law to make it more difficult for cities to take that
step. The law, which took effect this year, requires
municipalities to pursue mediation with creditors or declare a
fiscal emergency before seeking bankruptcy protection.

San Bernardino is poised to become the first California
city to bypass mediation with creditors under the law, City
Attorney James Penman said in an interview.

The City Council has scheduled a vote July 16 to declare a
fiscal emergency, allowing San Bernardino to skip a 60-day
neutral evaluation process in which creditors have a right to
participate, Penman said late yesterday.

“We don’t believe we have enough cash flow to get through
the next 60 days,” he said. “We believe our situation is
pretty secure” to qualify to bypass mediation.

San Bernardino and its agencies have more than $220 million
of debt, including $48.6 million of taxable pension-obligation
bonds, according to financial statements.

Rating Reduction

Standard & Poor’s lowered its rating on the city’s lease-revenue bonds yesterday by 12 steps to CC, or junk, from BBB+,
the third-lowest investment grade. The rating company said San
Bernardino has depleted its cash, which could impair its ability
to pay its bills. It put the credit on watch for future cuts.

Insolvencies in Stockton, San Bernardino and Mammoth Lakes
are three cities out of 482 in California, said Tom Dresslar, a
spokesman for California Treasurer Bill Lockyer.

“The notion that cities are chomping at the bit now to
file for bankruptcy is misplaced,” Dresslar said yesterday in a
telephone interview. “Most cities want to navigate through the
fiscal straits they’re in without having to file for bankruptcy.
If you take that route, the harm extends for years and years
into the future.”

The state is poised to borrow an estimated $10 billion next
month to pay bills until the bulk of tax receipts are collected
later in the year.

“We expect heavy investor demand for those revenue-anticipation notes, and we fully anticipate getting a good deal
for taxpayers,” Dresslar said. “We don’t see the recent events
adversely affecting us at all.”

James Spiotto, a partner who leads the bankruptcy group at
Chapman & Cutler LLP in Chicago, said there have been 641
municipal bankruptcies since 1937. He said Stockton and Mammoth
Lakes are the only U.S. cities to file this year.

“Three does not make a trend,” said Spiotto, who helped
Congress write amendments to Chapter 9. “What this really is is
a wake-up call to everybody. Are people addressing their
problems early enough?”

Chapter 9 is a process and not a solution, he said.

“The day after you file a Chapter 9, if there is a bad
economy, there’s still a bad economy,” Spiotto said. “If you
have problems with your workers, you still have them.”